Vaccinations and policy stimulus to drive recovery - Capital Economics
Canada Economics

Vaccinations and policy stimulus to drive recovery

Canada Economic Outlook
Written by Stephen Brown

The third wave of COVID-19 means that the restrictions on activity will be in place for longer than we assumed, but the economy is poised to recover strongly once vaccinations reach a critical mass, especially with the help of an additional investment-focused stimulus. We forecast GDP growth of 6.0% this year and 4.0% in 2022. As output will then be slightly above potential, we expect a slowdown to a more sustainable 2.3% in 2023.

  • Overview – The third wave of COVID-19 means that the restrictions on activity will be in place for longer than we assumed, but the economy is poised to recover strongly once vaccinations reach a critical mass, especially with the help of an additional investment-focused stimulus. We forecast GDP growth of 6.0% this year and 4.0% in 2022. As output will then be slightly above potential, we expect a slowdown to a more sustainable 2.3% in 2023.
  • External Demand – Exports have not proved as weak a link as we feared and should do well this year now that the US economy is re-opening. That said, once the international travel restrictions are lifted, services imports are likely to rise by more than exports, so we expect net trade to be a drag on GDP for most of the next 18 months. Likewise, the current account deficit is set to widen in 2022.
  • Domestic Demand – The substantial policy support during the first year of the pandemic means that household and firms are in a strong position to start spending and investing again once the economy re-opens. We expect broad-based gains in consumption and business investment will translate into domestic demand growth of 5.0% this year, 4.6% in 2022 and 2.5% in 2023.
  • Inflation – Supply constraints have already pushed up goods inflation and will contribute to higher services inflation as restrictions are lifted, causing core inflation to rise above 2% this year. While core and headline inflation should fall in 2022, as the supply constraints ease and oil prices drop back, we expect both measures to average more than 2% in 2023, as GDP rises above potential.
  • Monetary & Fiscal Policy – The forthcoming investment-focused fiscal stimulus should be equivalent to 1.5% of GDP per year and will help to support the recovery, especially as the Bank of Canada will wait longer than in the past before raising interest rates. While we expect the Bank to bring its asset purchases to a close by the end of 2021, we think it will wait until the start of 2023 to raise rates.
  • Long-Term Outlook – Immigration is likely to rebound strongly, but the ageing population still presents a headwind to GDP growth this decade. We see scope for potential GDP growth to rise from 2030 as labour force and productivity growth pick up. Meanwhile, the changing institutional approach to policy means there is reason to expect inflation to be higher in the coming decades than the recent past.

Key Forecast Table

Table 1: Key Canada Forecasts

% q/q annualised

2021

2022

2023

Annual (% y/y)

(unless otherwise stated)

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

2021

2022

2023

 

Demand

GDP

5.5

3.0

6.5

5.5

3.6

3.2

2.4

2.3

2.2

2.1

2.0

1.9

6.0

4.0

2.3

Final Consumption

2.0

2.9

8.9

6.6

5.1

3.6

2.2

2.2

1.9

1.6

1.6

1.6

4.7

4.9

2.0

– Household Consumption

2.0

3.2

11.5

8.2

6.1

4.1

2.0

2.0

2.0

1.6

1.6

1.6

5.2

5.8

2.0

– Government Consumption

2.0

2.0

2.6

2.6

2.6

2.6

2.6

2.6

1.6

1.6

1.6

1.6

3.3

2.6

2.0

Private Fixed Investment

1.3

0.9

1.5

2.5

2.5

2.6

3.6

4.1

3.1

3.6

3.2

3.2

5.8

2.5

3.4

– Business Fixed Investment

2.4

5.1

6.0

7.9

7.7

7.8

7.8

7.1

5.4

5.4

4.7

4.7

1.6

7.4

6.0

– Machinery & Equipment

4.1

6.1

10.4

10.4

10.4

10.4

10.4

8.2

6.1

6.1

4.1

4.1

11.0

10.0

6.9

– Non-Residential Structures

0.0

4.1

4.1

8.2

8.2

8.2

8.2

8.2

6.1

6.1

6.1

6.1

-4.7

7.5

6.9

– Intellectual Property

6.1

6.1

4.1

3.0

2.0

2.0

2.0

2.0

2.0

2.0

2.0

2.0

4.2

2.7

2.0

– Residential Investment

0.0

-3.9

-3.9

-3.9

-3.9

-3.9

-2.0

0.0

0.0

1.0

1.0

1.0

10.6

-3.5

-0.1

Government Fixed Investment

2.0

6.1

7.4

9.1

9.1

9.1

9.1

9.1

8.2

8.2

6.1

6.1

7.2

8.7

8.1

Final Domestic Demand

1.9

2.7

7.5

6.0

4.9

3.7

2.7

2.8

2.4

2.2

2.1

2.1

5.0

4.6

2.5

Exports

7.2

2.0

7.8

4.5

4.1

4.1

4.1

3.2

2.8

2.6

2.2

2.2

6.1

4.4

3.0

Imports

-2.0

6.6

10.4

8.2

7.0

5.7

4.5

2.8

2.4

2.0

2.0

1.6

7.4

6.8

2.8

Labour Market

Unemployment Rate (%)

8.3

7.4

6.8

6.5

6.3

6.1

5.9

5.8

5.7

5.6

5.5

5.5

7.2

6.0

5.6

Employment (%y/y)

-0.8

13.3

5.4

3.5

3.1

2.4

1.9

1.8

1.6

1.4

1.3

1.1

5.4

2.3

1.4

Prices (%y/y)

Consumer Prices

1.5

3.0

2.8

2.5

2.0

1.6

1.5

1.7

1.9

2.1

2.2

2.4

2.4

1.7

2.1

Core Consumer Prices1

1.9

2.0

2.2

2.0

1.9

1.8

1.8

1.9

2.0

2.2

2.2

2.2

2.0

1.8

2.2

Markets (end period)

Overnight Target Rate (%)

0.25

0.25

0.25

0.25

0.25

0.25

0.25

0.25

0.50

0.50

0.75

1.00

0.25

0.25

1.00

10 Year Gov’t Bond Yield (%)

1.50

1.75

1.90

2.00

2.05

2.10

2.15

2.25

2.35

2.40

2.45

2.50

2.00

2.25

2.50

CADUSD Exchange Rate

0.79

0.80

0.82

0.82

0.81

0.80

0.79

0.78

0.79

0.80

0.81

0.82

0.82

0.78

0.82

Other

Current Account (% of GDP)

-1.5

-1.8

-2.0

-2.2

-2.4

-2.6

-2.6

-2.6

-2.5

-2.3

-2.2

-2.0

-1.9

-2.5

-2.2

Federal Budget Bal. (% of GDP)

-7.0

-4.0

-3.0

1 CPI-trim. Sources: Refinitiv, CE


Overview

Vaccinations and policy stimulus to drive recovery

  • High rates of household and corporate saving, alongside additional fiscal stimulus, mean the economy is poised to recover strongly once the COVID-19 vaccinations reach critical mass. We forecast GDP growth of 6.0% this year and 4.0% in 2022. As output will then be slightly above potential, we expect a slowdown to a more sustainable rate of 2.3% in 2023.
  • The third wave of COVID-19 (see Chart 1) means that the restrictions on activity will be in place for longer than we initially assumed, but the economy should do well once the vaccination program reaches critical mass in late summer.
  • The fiscal support already provided, as well as the further investment-focused stimulus to come, means fiscal policy will provide a larger boost than in most countries. Canada should also benefit more than most from the policy support provided in the US. (See Chart 2.)
  • The measures enacted so far have helped to support high rates of household (see Chart 3) and corporate saving. We have assumed that households will quickly boost their spending as the economy re-opens, with the saving rate falling back to pre-pandemic levels. If households also chose to spend a high share of the savings they have accumulated in the past year, consumption could rise by even more than we forecast.
  • One risk to the outlook stems from the excesses in residential investment. (See Chart 4.) We expect the structural changes caused by the pandemic to keep home sales, renovations and new construction elevated for some time but, in an environment of rising interest rates, residential investment will inevitably fall, especially if immigration does not recover in 2022 as we assume.
  • Although the output gap that opened up last year would normally be consistent with core inflation remaining low (see Chart 5), we think it is likely to rise above 2% this summer. Supply shortages are feeding through to goods inflation and we think services inflation will also spike as coronavirus restrictions are lifted. Core inflation should fall back below 2% in 2022, as some of those supply constraints ease but, with the output gap set to close next year, we see core inflation rising again in 2023. (See Chart 6.)
  • Our forecasts for the output gap and inflation would normally be consistent with the Bank of Canada raising rates in early 2022. That is what financial markets are now pricing in (see Chart 7), even though the Bank has said it will wait longer to raise interest rates, specifically until it sees evidence that inflation of 2% will be “sustainably achieved”. Market pricing may reflect the view that the boom in housing will force the Bank to tighten sooner than it plans. (See Chart 8.)
  • While a sustained period of strong house price inflation could cause the Bank to change its approach, our forecasts ultimately show that inflation will be below 2% in 2022 as core inflation eases and oil prices fall. As a result, even though we expect the Bank to adopt a more positive tone this year, we continue to think that it will wait until 2023 before raising rates. We assume the Bank will hike three times that year, to take the policy rate to 1.0%. (See Chart 7 again.) If the Bank adopted an average inflation target in this year’s review of its policy framework, it might wait longer to raise rates.

Overview Charts

Chart 1: COVID-19 Cases per 100,000 (7d sum)

Chart 2: Planned Additional Spending & Foregone Revenue in Response to COVID-19 (% of GDP)

Chart 3: Household Saving Rate (% of Disp. Income)

Chart 4: Residential Investment (% of GDP)

Chart 5: Output Gap & Core Inflation

Chart 6: CPI Inflation (%)

Chart 7: BoC Policy Rate (%)

Chart 8: Home Sales-to-New Listing Ratio & House Prices

Sources: Refinitiv, Bloomberg, Capital Economics


External Demand

Current account deficit to widen

  • With the US economy booming, exports should continue to recover this year but, as services imports are likely to rise by more than exports once the international travel restrictions are lifted, we expect net trade to be a drag on GDP for most of the next 18 months.
  • The export components of the CFIB Business Barometer and Markit manufacturing PMI suggest that the outlook for external demand is improving. (See Chart 9.) That likely reflects the faster re-opening in the US, which is already benefitting energy exporters. Canadian firms have captured market share south of the border, with oil exports rising to a record high in January and Canada accounting for 19% of petroleum products consumed in the US this year, up from 17% in 2019. (See Chart 10.)
  • This means that pipeline capacity is becoming an issue again and there is a risk that Canadian firms will lose market share now that US shale production is showing signs of recovery. US refiners tend to favour the heavy grades from Canada, however, so we expect the completion of the Enbridge Line 3 pipeline expansion to support a further rise in oil exports in 2022.
  • The outlook for manufacturing exports, which have yet to recover as strongly as natural resource exports (see Chart 11), is still somewhat uncertain. While the current disruption from the global semiconductor shortage should eventually be resolved there is substantial uncertainty about the degree to which reduced business travel will permanently weigh on demand for autos and aircraft. Moreover, exports may suffer if the US starts to adopt electric vehicles (EVs) at a faster pace, given the lack of EV production in Canada.
  • Goods export volumes should at least continue to recover, and probably at a faster pace than goods imports. Following their strong run last year, consumer goods imports will now level off, as households pivot back to spending on services. (See Chart 12.)
  • The loonie has been trading around $0.80 in recent weeks, its strongest since 2018, and we expect it to rise to $0.83 later this year. But we do not expect that strength to be sustained, with the loonie falling to $0.78 in 2022 as oil prices correct. The big picture is that the real effective exchange rate remains well within the range it has moved in since the 2014/15 oil price bust. We therefore doubt that this further short-term appreciation will cause too much pain for exporters. If anything, long-run trends still suggest there is still scope for the trade balance to improve (see Chart 13), but that will likely depend on policies such as measures to better incentivise EV production.
  • A recovery in foreign travel will eventually weigh on the trade balance, because more Canadians normally travel abroad than foreigners come to Canada, so services imports will rebound more sharply once the travel restrictions are lifted. (See Chart 14.) We have assumed foreign travel gradually recovers from the third quarter of 2021.
  • The relatively larger boost to services imports is the main reason why we expect overall imports to outpace exports from the second half of this year. We expect the gap to narrow from mid-2022, as the recovering global economy continues to benefit capital and intermediate goods exports. (See Chart 15.) Our forecasts imply that the current account deficit will widen to 2.5% of GDP by early 2022, although the deficit would still be of little concern at that level. (See Chart 16.)

External Demand Charts

Chart 9: Surveys of Export Orders & Foreign Demand

Chart 10: Oil Exports to the US

Chart 11: Export Volumes ($bn, 2015 prices)

Chart 12: Retail Sales & Consumer Goods Imports ($bn)

Chart 13: Real Exchange Rate & Real Trade Balance

Chart 14: Travel Services Trade (% of GDP)

Chart 15: Exports & Imports ($bn, 2015 Prices)

Chart 16: Current Account Balance (% of GDP)

Sources: Refinitiv, Bloomberg, Capital Economics


Domestic Demand

Services consumption to rebound strongly when restrictions are lifted

  • We expect broad-based gains in consumption and business investment to translate into domestic demand growth of 5.0% this year, 4.6% in 2022 and 2.5% in 2023.
  • The elevated household saving rate leaves ample scope for consumption to rebound. (See Chart 17.) Our forecasts for consumption growth of 5.0% this year, 5.7% in 2022, and 2.0% in 2023 assume that households spend a more normal share of their income but keep most of the funds they saved during the pandemic. If they were to draw down those savings too, consumption could grow much more strongly than we have factored in.
  • Consumption will also be supported by the recovering labour market. Most of the remaining weakness is concentrated in a handful of high-contact service sectors, so the unemployment rate should drop sharply as restrictions are eased. We expect the unemployment rate to fall to 6.5% by the end of 2021.
  • The remaining lost ground will take longer to make up given the scarring in some sectors. Nevertheless, with the government gauging its policy support on labour market conditions and the Bank of Canada also keeping a firm eye on employment, it seems likely that the unemployment rate will return to its pre-pandemic low of 5.5% in 2023. (See Chart 18.)
  • One risk is that the current elevated level of residential investment is not sustained. Residential investment has surged to 9.3% of GDP, up by 2%-points since the pandemic. (See Chart 19.) We assume that it will gradually decline over the next two years, but remain above its pre-pandemic trend, as people adjust to the structural changes caused by the pandemic and house prices continue to rise. Our forecasts assume that immigration rebounds in 2022. With the ratio of housing starts to population growth currently very high (see Chart 20), if immigration does not rebound then residential investment could fall even more sharply.
  • Businesses have also acquired substantial savings, both relative to the pre-pandemic trend and their debt levels. (See Chart 21.) This strong position suggests that firms will start to rebuild their inventories this year, after the sharp fall last year (see Chart 22), and fixed capital spending should also benefit.
  • That said, despite the recent strength of oil prices, there are still signs of caution in the important oil and gas sector. While oil production has now fully recovered, firms are not engaging in new drilling with much enthusiasm. (See Chart 23.) That is perhaps due to concerns that the current level of oil prices will not be sustained or about the regulatory outlook.
  • The government has pledged to keep hiking the carbon tax to meet its commitment to make Canada net carbon neutral by 2050. Those measures will weigh heavily on oil and gas investment. Admittedly, they could also spur investment in battery-related minerals like lithium, nickel and cobalt, but those will only offset a fraction of the oil declines. (See Chart 24.)
  • Given these headwinds, we expect it to take until late 2022 for machinery & equipment and engineering investment to reach pre-pandemic levels. That means it will take until mid-2022 for business investment to surpass the pre-pandemic level, in contrast to our view that consumption will fully recover this year.

Domestic Demand Charts

Chart 17: Household Saving Rate (% of Disp. Income)

Chart 18: Unemployment Rate (%)

Chart 19: Residential Investment (% of GDP)

Chart 20: Ratio of Housing Starts to Population Growth

Chart 21: Non-Financial Corporations’ Currency & Deposit Assets

Chart 22: NFC Capital Acquisitions ($bn, ann.)

Chart 23: Oil Production & Rigs

Chart 24: GDP (2019, $bn)

Sources: Refinitiv, Bloomberg, CREA, Capital Economics


Inflation

Rise in inflation this year won’t be sustained

  • Supply constraints have already lifted goods inflation and, as coronavirus restrictions are eased, constraints will contribute to higher services inflation too, causing core inflation to rise above 2% this year. While core and headline inflation should fall in 2022, as those supply constraints ease and oil prices drop back, we expect both to rise above 2% again in 2023.
  • The recent strength of oil prices, and our forecast that WTI will rise further to $72 in the third quarter, will keep inflation above 2% for most of this year. We do not expect such high oil prices to be sustained, however, given the potential for global supply to rebound. As WTI drops to $57 in 2022, we expect energy prices to take headline inflation back below 2%. (See Chart 25.)
  • Our forecast that it will take until the end of 2022 for the output gap to close would normally be consistent with core inflation rising to 2% in 2023. (See Chart 26.) We expect the re-opening to push core inflation above 2% as soon as this summer, however, thanks to price gains in high-contact service sectors. Firms’ selling price expectations already point to higher inflation (see Chart 27), in part due to the supply shortages that are driving up goods prices.
  • Limited wage pressures suggest that core inflation of more than 2% is unlikely to be sustained beyond the initial re-opening period. Firms’ wage expectations still only look consistent with annual wage growth of 2.5%. (See Chart 28.) In the past couple of decades, wage growth of nearer 4% has been necessary for core inflation to settle at 2%. (See Chart 29.)
  • The situation could admittedly change quickly. While the overall unemployment rate remains elevated, the unemployment rates in some industries are now closing in on their pre-pandemic lows. (See Chart 30.) Given limited skills cross-overs between the high-contact service sectors where unemployment remains high and the remaining sectors, it is possible that wage growth will rise faster than normal.
  • Even if that is the case, the further appreciation of the loonie that we expect should act as a pressure valve over the next 12 months. Our forecast that it will appreciate to $0.83 later this year, from $0.79, suggests that imported goods inflation will be negative for the rest of 2022. (See Chart 31.) While imported goods inflation would then turn positive again in 2022 if the loonie depreciates as we forecast, that rise would coincide with the fall in energy inflation.
  • Overall, we expect headline inflation to average 2.4% this year before it declines 1.7% in 2022. We expect CPI-trim to peak at 2.3% in the summer, before it falls to 1.7% in mid-2022.
  • In 2023, we expect GDP to be above potential and the unemployment rate to fall to its joint-lowest rate since 1970. In that environment, there is likely to be more sustained upward pressure on wages and we expect both core inflation and headline inflation to move above 2%. (See Chart 32.)
  • Whether inflation is sustained at more than 2% beyond then will depend on whether the Bank of Canada’s policy framework changes. If policymakers continue to place greater emphasis on inequality and employment outcomes than they have done in the past, then inflation would likely be higher in the next decade than in the previous one.

Inflation Charts

Chart 25: WTI Oil Price & Energy CPI (% y/y)

Chart 26: Output Gap & Core Inflation

Chart 27: Firms’ Selling Price Expectations & Core Inflation

Chart 28: Business Outlook Survey Wage Expectations & Private Sector Wages

Chart 29: Wages & Core Inflation

Chart 30: Unemployment Rates (%)

Chart 31: Exchange Rate & Imported Consumer Goods Prices

Chart 32: CPI Inflation (%)

Sources: Refinitiv, Capital Economics


Monetary & Fiscal Policy

Additional fiscal stimulus to support the recovery

  • Additional investment-focused fiscal stimulus will help drive the recovery this year, especially as the Bank of Canada will wait longer than in the past before raising interest rates.
  • The government will use its 2021 Budget to set out an investment stimulus, along the lines signalled in the 2020 Fall Update, likely worth 1.5% of GDP per annum for the next three years. That would bring the total value of the discretionary fiscal support provided since the pandemic to 20% of GDP. While that would be lower than the support already outlined in the US, at 25% of GDP, it would be much larger than in most economies. (See Chart 33.) Despite the additional spending plans, the strong gains in GDP we forecast mean the budget deficit should narrow sharply, from 16% of GDP in 2020 to 3.0% in 2023. (See Chart 34.)
  • A potential concern is that some of this stimulus will be offset by austerity at the provincial and local government levels. The 2021 budgets announced by Ontario and Quebec suggest this will generally not be the case but, with most provinces seeing their debt-to-GDP ratios jump last year (see Chart 35), some provincial governments might be getting nervous following the recent rises in bond yields. Even before the pandemic, the long-run fiscal outlook for the provinces already looked challenging, because they are responsible for the costs of supporting Canada’s ageing population. (See Chart 36.)
  • This long-run issue does not seem to be of much concern for the Bank of Canada currently, as it brought its provincial bond and bill buying programs to a close in March. Given the Bank’s growing concerns about further strong gains in house prices (see Chart 37), it also seems committed to bringing its federal bond purchase program to a close this year. We assume it will gradually cut the pace of its purchases at every other policy meeting starting in April. (See Chart 38.)
  • The resilience of the economy during the second wave of COVID-19 suggests the Bank will adopt a more positive tone over the rest of the year, but we continue to think it will wait until early 2023 before raising interest rates. That is because the falls in commodity prices that we forecast in 2022 will reduce the upside risks to inflation, and because we expect the Bank to be unwilling to tighten by much until the Federal Reserve is also raising rates. We do not expect the Fed to move until late 2023.
  • Our forecasts imply the Bank will begin to raise rates six months later than overnight index swaps suggest. (See Chart 39.) Despite this view, we see scope for bond yields to rise against the backdrop of the strengthening global economy, rising inflation and high debt issuance. We forecast that the 10-year yield will rise from 1.5% currently to 2.0% by the end of 2021. The correction in oil prices we expect should keep it from rising by as much as the US 10-year in 2021, but we expect the gap to close again in 2023, with both yields ending the year at 2.5%. (See Chart 40.) Our forecasts lead us to expect a further rise in the loonie to $0.82 this year.
  • When the Bank last tightened in 2017/18, it was wary about the potential negative effects of higher interest rates on the housing market and household spending. As house prices will look even more stretched relative to incomes by 2023, the Bank might end up adopting a slower pace of tightening than markets are assuming. Similarly, if the Bank were to adopt an average inflation target regime in this year’s review of its monetary policy framework, then it might wait longer before raising interest rates.

Monetary & Fiscal Policy Charts

Chart 33: Planned Additional Spending & Foregone Revenue in Response to COVID-19 Crisis (% of GDP)

Chart 34: Federal Government Budget Deficit (% of GDP)

Chart 35: Provincial Debt (% of GDP)

Chart 36: Debt-to-GDP Ratios (%)

Chart 37: Sales-to-New Listing Ratio & House Prices

Chart 38: BoC Bond Holdings

Chart 39: Policy Rate Implied by OIS (%)

Chart 40: 10-Year Bond Yields (%)

Sources: Refinitiv, Bloomberg, Trevor Toombes/FinancesOfTheNation.ca


Long-term Outlook

Slower labour force growth to keep a lid on GDP growth this decade

  • The ageing population will act as a headwind this decade, but potential GDP growth is set to rise from 2030 onwards, as labour force and productivity growth rebound. Meanwhile, there is good reason to expect inflation to be higher in the coming decades than in the recent past.
  • Even allowing for strong immigration, the UN expects the working-age population to fall from 61% of the total to 57% by 2030, with the share aged over 65 rising to 23%, from 18%. (See Chart 41.) This means potential labour force growth is set to slow to just 0.2% per year in the late 2020s, down sharply from annual growth of 1% in the five years before the pandemic.
  • The effect of slower labour force growth should be mostly offset by higher productivity growth. The weak rate of annual productivity growth in the past five years, of 0.3%, was partly due to the negative effect of the 2014/15 slump in oil prices. We do not expect a resurgence in the oil sector, given global oil demand will soon peak and the pandemic has worsened the debt situation, but there are nevertheless two reasons why productivity growth should rise.
  • First, the pandemic has accelerated the adoption of new technologies across almost every sector of the economy. Second, the pandemic has also accelerated political trends, with the populace now even more eager to see the government take an activist approach to fiscal policy. This suggests the government’s recent commitment to a large investment program is a sign of things to come, which will help to support overall investment.
  • The upshot is that we see potential GDP growth slowing slightly from a little under 2% before the pandemic to 1.7% between 2025 and 2029, before it picks up to 2.2% over the following two decades. (See Chart 42.)
  • The changing institutional approach to policy setting also presents upside risks to inflation. The government has hinted that it will target full employment, which together with demographic changes leads us to think the unemployment rate will drop to 5% in the coming decades, compared to an average of 6.9% in the past 20 years. Lower unemployment should lead to higher inflation, which the Bank of Canada seems more likely to tolerate given signs it is growing concerned about the effects of its current policy framework on inequality. We expect the Bank to allow inflation to sit in the upper half of its 1% to 3% target range, averaging 2.5% between 2030 and 2050.
  • The Bank’s approach could change by more than we assume following the 2021 review of its monetary policy framework, but for now the pick-up we forecast still means inflation will average about 0.5%-points below that in the US. This difference means the exchange rate is set to appreciate in Canada’s favour in nominal terms over the coming decades, but be little changed in real terms.
  • The government’s new approach and pressure on the public finances from the ageing population means we are forecasting a general government deficit of 3.5% of GDP between 2030 and 2050. Our estimate of potential nominal GDP growth of over 4% over that period implies the debt-to-GDP ratio will still drop back from the near 110% recorded this year. (See Chart 43.) It is trends in potential GDP growth and inflation, rather than public debt, that lead us to think that interest rates will rise in the coming decades. By the 2050, we see the policy rate at 3.25% and 10-year yield at 4.0%. (See Chart 44.)

Long-term Charts

Chart 41: Share of Population (%)

Chart 42: Contributions to Real GDP Growth (%)

Chart 43: General Government Budget Balance & Gross Debt (% of GDP)

Chart 44: Policy Rate & 10-Year Bond Yield (%)

Sources: Refinitiv, Capital Economics


Key Forecasts (% y/y, Averages, unless otherwise stated)

2006-2010

2011-2015

2016-2020

2021-2025

2026-2030

2031-2050

Real GDP

1.2

2.2

0.4

3.2

1.6

2.3

Real consumption

3.1

2.3

0.7

3.6

1.6

2.3

Productivity

0.1

1.0

0.2

1.5

1.3

1.9

Employment

1.0

1.1

0.3

1.7

0.3

0.4

Unemployment rate (%, end of period)

8.0

6.9

9.5

5.7

5.5

5.0

Wages

2.9

3.1

5.0

2.3

3.8

4.1

Inflation (%)

1.7

1.7

1.6

2.1

2.4

2.4

Policy interest rate (%, end of period) (1)

1.00

0.50

0.25

1.25

1.75

3.25

Ten-year government bond yield (%, end of period) (2)

3.12

1.40

0.85

2.25

2.50

3.75

Government budget balance (% of GDP, average over period)

-1.0

-1.4

-3.5

-3.4

-3.1

-3.5

Gross government debt (% of GDP, average over period)

81

91

110

101

98

85

Current account (% of GDP, average over period)

-0.8

-3.0

-2.5

-1.9

-2.0

-2.0

Exchange rate (Canadian dollar per US dollar, end of period)

0.99

1.39

1.27

1.17

1.16

1.08

Nominal GDP ($bn, end of period)

1,677

1,433

1,707

2,378

2,903

7,937

Population (millions, end of period)

34

36

38

39

41

46

Sources: Refinitiv, UN, Capital Economics


Stephen Brown, Senior Canada Economist, +1 416 874 0514, stephen.brown@capitaleconomics.com